(PUB) Investing 2015

the fund. For those who are indexing purists, this is gospel, but as with so much in the world of academics, the human factor makes a mess of dogma. Consider that while Total World Stock Index is now seven years old and opened at a time when investors had begun to suffer massive losses and could have easily switched funds with little or no tax consequence, it’s collected only a bit more than $7 billion in assets—hard- ly a ringing endorsement by indexing believers. Total International Stock Index , which doesn’t invest in the U.S. at all, is 23 times bigger. Unfortunately, I’ve noticed that the arguments for and against investing in foreign funds tend to follow perfor- mance. Foreign stocks are attractive when they are doing well, and much less so when they aren’t. Hence, you haven’t seen a whole lot of table-pounding for foreign shares until very recently. Take a look at the chart below, which shows the relative performance of Total Stock Market and Total International Stock since the foreign index fund’s inception, and you’ll see why most investors have remained shy of the for- eign markets. When the line is rising, U.S. stocks are outperforming foreign stocks (all based on U.S. dollar returns, of course). When the line is falling, foreign stocks are tops. As the chart shows, there was a long stretch from the mid-’90s to early 2002 when U.S. stocks led, followed by a long period of foreign stock outperformance until the middle of 2008. At the end of 2014, though, domestic stock dominance gave way to foreign stocks.

known unknowns are so myriad it looks like staying at home is a great idea. Plus, arguments for and against investing in overseas funds run the gamut and have recently received a lot of attention in the media. The argument for investing strictly in the U.S. is a favorite of former Vanguard Chairman Jack Bogle and his acolytes, who main- tain that there’s little diversification benefit in owning stock in non-U.S. companies because U.S. companies already derive a large share of revenues and often an even larger share of earn- ings from business conducted over- seas. Coca-Cola, the quintessential U.S. company, has a presence in virtually every foreign market you can think of. Coca-Cola may be based in Atlanta, but it is a global franchise earning profits in Egypt, Japan, Singapore and the U.K. Why bother buying a European soda maker when you can own Coke? Further, those who argue against investing overseas will warn that you add a new and unique risk to your portfolio when you invest in stocks that are denominated in non-dollar curren- cies—hence you shouldn’t do it. The pro-global pundits believe that most U.S. investors are woefully underinvested in foreign stocks and should have roughly half of their equity portfolio invested outside of the U.S. Vanguard currently says 40%, but that’s just the latest iteration of the company’s advice, which has steadily increased recommended allocations from 10% to 20% to 30% and now 40% of your stock holdings since the latest change just a few months ago. In fact, Vanguard could well be mov- ing towards the efficient market thesis that you should match the markets, globally, with your own portfolio. So 40% may not be the last stop in this journey. Because isn’t the efficient mar- ket theory what indexing is all about? Using Total World Stock Index as a proxy, for instance, the U.S. makes up just 48% of the value of the world’s stock markets. That would suggest that only 48% of your stock portfolio should be in U.S. stocks, and the other 52% should be in foreign stocks. And that’s exactly what you’ll get if you invest in

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some reallocating. As always, use the Model Portfolios as your guide. Let’s start with some basics. Foreign, international or global funds invest in companies based outside of the U.S., like Honda (Japan), Nestlé (Switzerland), Bayer (Germany), Nokia (Finland),Akbank (Turkey) or Samsung (Korea). (Global funds, of course, also invest in U.S. companies.) Foreign countries and markets are then usually divided into two buckets: Developed and emerging. Developed countries and markets tend to be mature economies with high levels of gross national income and have histori- cally been considered less risky than their emerging markets counterparts. Examples of developed international markets include Germany, the United Kingdom, France, Japan and Australia. Emerging markets, as their name implies, are in the earlier stages of economic development. That can mean they have newer capitalist economic systems and more fragile markets that are susceptible to missteps and insta- bility—factors that can add to volatil- ity and risk for investors. Examples of emerging economies include those in China, many countries in southeast Asia and eastern Europe, as well as countries in Latin America. Recently, emerging markets have been further subdivided into two groups: The more established emerging economies, such as China and India, and a group of “frontier” markets, such as Vietnam, Kenya and Ukraine, that are in even earlier stages of free-market and investment-market development. Why Bother? From an investor’s perspective, it’s an awfully big world out there. And right now it looks awfully messy out- side our boundaries. While the U.S. economy is growing (albeit slower then we’d like) and jobs seem plentiful, overseas we’re seeing economies in crisis (Greece), high rates of unem- ployment (Spain), political unrest (the Middle East and Africa) and uncertain political leadership (Brazil). In fact, the

Domestic vs. Foreign Stock Leadership

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Rising line = U.S. markets outperforming foreign markets

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Total Stock vs. Total Int’l Stock Index

0.80

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4 • Fund Family Shareholder Association

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